The 2 Biggest Risks to Future Social Security Benefits

The Social Security trust fund that pays the retirement benefits of more than 40 million Americans is projected to be insolvent by the year 2034. That's the conclusion of the 2014 Social Security Trustees report. If that happens, Social Security benefits stand to be cut by nearly a quarter.

It goes without saying that this is a problem. According to the Social Security Administration:

"Nine out of 10 individuals age 65 and older receive Social Security benefits."
"Social Security benefits represent about 38% of the income of the elderly."
"Among elderly Social Security beneficiaries, 52% of married couples and 74% of unmarried persons receive 50% or more of their income from Social Security."
"Among elderly Social Security beneficiaries, 22% of married couples and about 47% of unmarried persons rely on Social Security for 90% or more of their income."

What's behind this ominous trend? Demographics are the primary culprit.

The American population is getting older. In 1970, 18.9% of covered workers -- i.e., workers who have paid, or are paying, into the Social Security system -- were aged 60 or older. Today, that figure stands at 26.8%.

And things are getting worse. According to the U.S. Census Bureau, the percentage of the overall population (as opposed to covered workers) aged 65 and older is projected to grow from 16.9% today to 24.7% in 2035.

On a relative basis, this means that fewer people will be paying into the system for every person drawing out of it. That's unsustainable for a pay-as-you-go system unless Social Security taxes are increased or benefits are decreased.

But while this is the biggest threat to the primary Social Security trust fund, it isn't the only one. In fact, the decades-long decline in interest rates is almost just as important.

Money in the Social Security trust fund is invested in two types of fixed-income securities. The first are short-term "certificates of indebtedness" that range in duration from one to 364 days. The second are long-term "special-issue bonds," with a maturity of one to 15 years. At the end of 2014, for example, the trust fund held $57 billion worth of certificates of indebtedness and $2.67 trillion worth of special-issue bonds.

The problem is that the income from these investments is tied to interest rates, and interest rates have been on a decades-long descent since the double-digit inflation of the late 1970s and early 1980s.

In 1990, the Social Security retirement fund earned 9.02% on its portfolio. By the end of last year, it earned only 3.41%.

To put that in perspective, at 3.41%, the trust fund's $2.73 trillion in assets generate $93 billion in income; at 9.02%, it would earn $246 billion. In other words, the decline in interest rates since 1990 alone is currently costing the fund $153 billion per year in forgone income.

The net result is that the Social Security system is indeed in a perilous situation. That doesn't mean you can't rely on it past the year 2034, as the political pressure to come up with a solution will be powerful. But it does mean that there will be changes, some of which could decrease the average size of benefit checks in the future.

The article The 2 Biggest Risks to Future Social Security Benefits originally appeared on Fool.com.

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